Sunday, August 26, 2007


The fallout from the subprime credit crisis has yet to land everywhere. Although like Dorothy’s house plummeting into the land of Oz, it has landed hard on many struggling borrowers. [1]

An article yesterday on entitled “Muni bond funds hit by 'perfect storm'-Muni-arbitrage hedge funds could be behind disruption” discusses falling municipal bond prices.

James Grant who writes “Grants Interest Rate Observer” has an Op-ed piece in today’s New York Times, “The Fed’s Subprime Solution

Grant writes:

THE subprime mortgage crisis of 2007 is, in fact, a credit crisis — a worldwide disruption in lending and borrowing. It is only the latest in a long succession of such disturbances. Who’s to blame? The human race, first and foremost. Well-intended public policy, second. And Wall Street, third — if only for taking what generations of policy makers have so unwisely handed it.

Possibly, one lender and one borrower could do business together without harm to themselves or to the economy around them. But masses of lenders and borrowers invariably seem to come to grief, as they have today — not only in mortgages but also in a variety of other debt instruments. First, they overdo it until the signs of excess become too obvious to ignore. Then, with contrite and fearful hearts, they proceed to underdo it. Such is the “credit cycle,” the eternal migration of lenders and borrowers between the extreme points of accommodation and stringency.

Significantly, such cycles have occurred in every institutional, monetary and regulatory setting. No need for a central bank, or for newfangled mortgage securities, or for the proliferation of hedge funds to foment a panic — there have been plenty of dislocations without any of the modern-day improvements.

Late in the 1880s, long before the institution of the Federal Reserve, Eastern savers and Western borrowers teamed up to inflate the value of cropland in the Great Plains.[AUTHOR’ NOTE: See Footnote 1 for an interesting discussion of how the Wizard of Oz fits into this farmland run-up.] Gimmicky mortgages — pay interest and only interest for the first two years! — and loose talk of a new era in rainfall beguiled the borrowers. High yields on Western mortgages enticed the lenders. But the climate of Kansas and Nebraska reverted to parched, and the drought-stricken debtors trudged back East or to the West Coast in wagons emblazoned, “In God we trusted, in Kansas we busted.” To the creditors went the farms.


The Author’s post from Friday discussed the market manipulation committed by the “Plunge Protection Team”. We have also talked about the “Greenspan Put”, the well-founded belief that former Federal Reserve Chairman Alan Greenspan would protect investors from large losses (the purpose of a “put”) through monetary and open market actvity.

There is a phrase circulating in moderate to liberal economic circles that the last twenty years, especially the last seven years, have been a period where the government privatizes profits and socializes losses. Crony capitalism is endemic to the Bush administration and the Bush war in Iraq. And the taxpayer takes the hindmost. Odd, isn’t it, that the Author, an economic conservative and a social liberal/radical is attacking a far right administration from the right.

But let James Grant sum it up most elegantly and offer a ray of hope in Fed Chief Bernanke:

Now comes the bill for that binge and, with it, cries for even greater federal oversight and protection. Ben S. Bernanke, Mr. Greenspan’s successor at the Fed (and his loyal supporter during the antideflation hysteria), is said to be resisting the demand for broadly lower interest rates. Maybe he is seeing the light that capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich.


1. Many scholars, and the Author, believe that Frank Baum’s beloved book is a political and economic allegory about the 1890s. This brief description of possible political and economic interpretations is taken from Wikipedia:

Many of the events and characters of the book resemble the actual political personalities, events and ideas of the 1890s.[1] The 1902 stage adaptation mentioned, by name, President Theodore Roosevelt, oil magnate John D. Rockefeller, and other political celebrities.[1] (No real people are mentioned by name in the book.) Even the title has been interpreted as alluding to a political reality: oz. is an abbreviation for ounce, a unit familiar to those who fought for a 16 to 1 ounce ratio of silver to gold in the name of bimetallism, though Baum stated he got the name from a file cabinet labeled A-N and O-Z. It should also be noted, however, that in later books Baum mentions contemporary figures by name and takes blatantly political stances without the benefit of allegory including a condemnation in no uncertain terms of Standard Oil.

The book opens not in an imaginary place but in real life Kansas, which in the 1890s was well-known for the hardships of rural life, and for destructive tornadoes. The Panic of 1893 caused widespread distress in rural America. Dorothy is swept away to a colorful land of unlimited resources that nevertheless has serious political problems.[1] This utopia is ruled in part by people designated as wicked. Dorothy and her cyclone kill the Wicked Witch of the East. The Witch had previously controlled the all-powerful silver slippers (which were changed to ruby in the 1939 film). The Wicked Witch of the West tries to seize the silver slippers, but cannot because they are already on Dorothy's feet. The slippers will in the end liberate Dorothy but first she must walk in them down the golden yellow brick road, i.e. she must take silver down the path of gold, the path of free coinage.

What the Author found interesting is the image of a farmhouse from Kansas, in the midst of an Economic Panic, falling on the Wicked Witch of the East, a metaphor for Eastern Bankers.


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